When the FOMC pronounced on monetary policy this week, it cleared things up – not – by saying that, “…near-term risks to the economic outlook appear roughly balanced.” Tea-leaf readers quickly turn to cat disembowelment to figure this out, but I think we’ll need to await predictions from the Druids during their winter-solstice celebrations to learn how rate rises will fare in December. What I know now is that balance – rough or even ragged – is not to be found in U.S. income distributions. As a new FedFin paper details, the reason for this is in part – albeit only in part – that the U.S. central bank has skewed asset prices and suppressed interest rates. Although income inequality has many causes, the FRB should act quickly to remedy those within its reach.
The intersection between the FRB’s actions and income inequality are complex, but clear from the data we present in our new study. Both the size of the FRB’s portfolio and its ultra-low rates contribute to a widened income distribution over the past eight years, but the two policies taken together and for so long combine to considerable, adverse effect.
In short, the maelstrom of monetary and regulatory policy now leads first to asset prices that make the rich richer, the middle stuck in the mud, and the poor poorer. As is evident from an array of data in our paper, the assets wealthier people hold – e.g., stocks and bonds – have appreciated far more than the assets low- and moderate-income families hope to accumulate (principally homes where values are only now barely recovering for higher-price houses and are stuck under water for affordable homes). New rules make this worse because, even if mortgage finance now is safer, the rules also crowd out first-time home buyers and many others for whom home ownership is the primary path to wealth accumulation.
Secondly, monetary policy and the new rules combine to exacerbate income inequality by keeping deposit and savings rates in negative territory from a real-rate of-return perspective. It is thus now impossible for retirees to ensure quality of life and others to save for secure retirement through the deposit and investment options suitable for and available to low/mod-income households. Current income-distribution distortions are thus likely only to get worse faster as savings fall into ever deeper holes. Contemplate rising inflation without rising savings returns and be particularly afraid.
Some have suggested that when rates rise, so too will deposit returns and all will then be well. Here’s where the new rules come in with a bang: even when rates rise, banks may not want new deposits and thus will not raise rates anywhere close to the levels at which low/mod households could start to climb out of the consumption trap and save for the future. Flooded by wholesale deposits resulting in part from new MMF regulation and more fundamentally the problems of finding lending opportunities that meet both profit needs and regulatory demands, banks big and small are changing asset composition in ways that pose long-term challenges to both sustainable wealth and income improvement for anyone who didn’t start out well off in 2008.
The problem in the intersection between amazingly accommodative monetary policy and income inequality is thus to be found by tracking two intersecting phenomena the FRB did not anticipate and for which its own data-driven analytics are ill-prepared. The first problem is that the FRB’s unprecedented actions were intended not only to press hard against looming financial panic (successfully accomplished), but also to be quickly normalized as soon as conditions stabilized. Eight years after 2008, accommodative policy has gotten only more obliging even as U.S. economic recovery is not only slow, but also fragile.
The second reality in which FRB monetary policy resides is the post-crisis regulatory framework it has played so large a part to build. Just as the goals of accommodative policy are worthy ones – higher employment and price stability – so too are those for the new rules – better banks in a calmer financial market. But rules have consequences and the cumulative cost of these consequences – still not contemplated by the FRB – determines winners and losers across the spectrum of financial products.
This might just be a shift in the competitive landscape with no policy impact. Our paper considers this – assessing if a shift of wealth-accumulating products for lower-wealth households can solve for asset-appreciation or savings-return obstacles to income equality. In short, we don’t think so due to the combination of financial-stability risk resulting from unregulated providers of large-scale financial services and the structure of many of the products non-banks offer to lower-income families.
FRB action since 2008 has been based on FRB understanding of the cost of over-tight monetary policy and over-lax prudential regulation. There is, though, another cost that requires careful and quick consideration: harm done to long-term U.S. economic prosperity and to renewed political functionality if income distribution gets still more skewed. Does the FRB have to hike rates or throw out the rules to reverse what it can of adverse income-distribution trends? Of course not. Should it do what it can as fast as it can? For sure.